Model Answer
0 min readIntroduction
The Indian tax system has undergone several revisions aimed at simplifying procedures, broadening the tax base, and enhancing revenue collection. The Union Budget 2018-19 brought significant changes to the taxation of capital gains and dividends, two crucial components of investment income. Prior to these changes, Dividend Distribution Tax (DDT) was levied on companies distributing dividends, while Long-Term Capital Gains (LCG) tax applied to profits from the sale of assets held for a specified period. The budget aimed to move towards a more equitable and efficient system, shifting the tax burden from companies to investors, and rationalizing LCGT provisions.
Pre-Budget Scenario (2017-18)
Before the 2018-19 budget, India followed a system where companies paid DDT on the dividends they distributed to shareholders. The DDT rates varied depending on the amount of dividend declared. This system was criticized for being inequitable as it resulted in a double taxation of dividends – once at the company level (DDT) and again in the hands of the shareholders when they received the dividend income. Long-Term Capital Gains tax was applicable on the sale of equity shares and other assets held for more than a specified period, typically 12 months for listed securities, with a concessional rate of 10% (plus surcharge and cess) on gains exceeding ₹1 lakh.
Changes Introduced in Union Budget 2018-19
Dividend Distribution Tax (DDT) Abolition
The most significant change was the abolition of DDT. The budget proposed to remove DDT altogether, effectively shifting the responsibility of paying tax on dividend income to the investors. This meant that investors would now be liable to pay tax on the dividend income they receive at their applicable slab rates. The government argued that this would make the tax system more transparent and equitable, as investors would be aware of the tax implications of their dividend income.
Long-Term Capital Gains Tax (LCGT) – Introduction of Section 111A
The budget introduced Section 111A in the Income Tax Act, 1961. This section stipulated that long-term capital gains arising from the sale of equity shares or equity-oriented mutual funds, where Securities Transaction Tax (STT) had been paid, would be taxable at a rate of 10% (plus surcharge and cess), without allowing any indexation benefit. Indexation benefit allows adjusting the cost of acquisition for inflation, reducing the taxable gain. Removing this benefit increased the tax liability for investors. This was done to address perceived loopholes and ensure a fairer tax regime.
Rationale Behind the Changes
- Simplification: The abolition of DDT simplified the tax structure by removing a layer of taxation.
- Equity: Shifting the tax burden to investors was seen as more equitable, as it ensured that those who actually benefited from the dividend income paid the tax.
- Revenue Enhancement: The government expected that the changes would lead to increased tax revenue, as a larger number of investors would be brought into the tax net.
- Addressing Tax Avoidance: The introduction of Section 111A aimed to curb tax avoidance strategies involving the sale of equity shares.
Impact of the Changes
The changes had a mixed impact. While the abolition of DDT was welcomed by companies, investors, particularly those in higher tax brackets, faced a higher tax burden on their dividend income. The removal of indexation benefit on LCGT also increased the tax liability for long-term investors. The stock market initially reacted negatively to the changes, but the impact stabilized over time. The changes also led to increased compliance as investors became more aware of their tax obligations.
| Tax Component | Pre-Budget (2017-18) | Post-Budget (2018-19) |
|---|---|---|
| Dividend Taxation | DDT paid by companies | Taxed in the hands of investors at applicable slab rates |
| LCGT on Equity | 10% (plus surcharge & cess) with indexation benefit | 10% (plus surcharge & cess) without indexation benefit (Section 111A) |
Conclusion
The changes to LCGT and DDT in the 2018-19 Union Budget represented a significant shift in India’s tax policy. While the abolition of DDT aimed to simplify the tax structure and promote equity, the removal of indexation benefit on LCGT increased the tax burden on long-term investors. The overall impact of these changes has been a subject of debate, with some arguing that they have made the tax system more efficient and equitable, while others contend that they have discouraged investment. Future budgets may need to revisit these provisions to strike a better balance between revenue generation and investment promotion.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.